DoD skeptical of companies' 'rosy' forecasts

Feb. 10, 2014 - 06:00AM
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WASHINGTON — Defense companies are telling investors that earnings-squashing budget pressures will soon ease, but DoD sees the future a bit differently, a Pentagon official said Wednesday.

A degree of relief had set in after the Murray-Ryan budget deal softened the slope of the budget drawdown, and companies have been telling investors that things should start to look up again after fiscal 2015.

“I think we’ve always said that we looked at ’14 and part of ’15 as being a transition year, and if you look at ’16 and look at the numbers, it ticks up even under sequestration,” Raytheon CEO Bill Swanson said during the company’s earnings call in late January. “When you look at the budget process, even with sequestration and the Budget Control Act, ’16 was always the year where there was an uptick and it started to come back again, even when you look at it ’17 and on the budgets start to increase.”

That’s been a common refrain among companies, but it may be too optimistic, said DoD’s acting industrial base chief, Elana Broitman, who spoke at the Cowen Aerospace/Defense & Transportation conference.

“We’ve gone through a lot of the year-end reports, and a lot of the larger companies in particular are reporting that while they’ve seen some of their sales take some small hits and maybe some more will come, that we’re really at the nadir of the pressure on their sales, and that things are going to be really rosy from there,” she said. “We’re not sure at DoD that we quite see the budget environment quite that way.”

Broitman said that some of those company forecasts are making it difficult for DoD to tell Congress about the pressure the agency is facing due to the sequester cuts.

“For us to be able to tell the story of what the sequester does to the defense environment, it’s harder when there are good profits at some of the larger companies,” she said. “If we don’t do anything that changes sequestration after fiscal year ’15, then we’re stuck with flat, no-inflation budgets which don’t take account of the new initiatives, new requirements, that need to be funded. Even the FY’15 number, which we’re grateful for, let’s recognize that it’s not a big bump from the sequestered level.”

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The past year took defense company stocks to record highs even as revenue declined across the industry. Most of the rise can be attributed to strong margins created by cost-cutting, plus enormous amounts of cash thrown at investors in the form of share repurchases and stock dividends.

“Even people in the defense industry are bemused at last year’s run-up in share prices,” said Loren Thompson of the Lexington Institute, a consultant for defense contractors and industry analyst. “The only way to keep stock prices at current levels is to offer hefty dividend yields and buy back shares at a rapid pace, but that means not investing in the business.”

Thompson noted that Raytheon may be better off than some other contractors because of the company’s strong overseas business, but that the cuts that will shape the industry in the coming years aren’t going anywhere.

“Sequestration is here to stay, and war supplementals are going away,” he said.

Broitman described a similar outlook.

“Sequester is the law of the land until fiscal year ’21,” Broitman said. “We certainly hope that Congress has lost its appetite for sequestration and we may be able to address sequestration longer-term, but there are absolutely no guarantees.” ■